SECTION 2. BACKGROUND

.01 Section 461(a) of the Internal Revenue Code provides that the amount of any deduction or credit must be taken for the taxable year that is the proper taxable year under the method of accounting used in computing taxable income.

.02 Section 1.461–1(a)(2)(i) of the Income Tax Regulations provides that, under an accrual method of accounting, a liability is incurred, and generally is taken into account for federal income tax purposes, in the taxable year in which (1) all the events have occurred that establish the fact of the liability, (2) the amount of the liability can be determined with reasonable accuracy, and (3) economic performance has occurred with respect to the liability (the “all events test”). See also § 1.446–1(c)(1)(ii)(A).

.03 Section 1.461–4(g)(6) provides generally that, if a taxpayer is liable to pay a tax, economic performance occurs as the tax is paid to the governmental authority that imposed it.

.04 Section 1.461–5(b)(1) provides a recurring item exception to the general rule of economic performance. Under the recurring item exception, a liability is treated as incurred for a taxable year if: (i) at the end of the taxable year, all events have occurred that establish the fact of the liability and the amount can be determined with reasonable accuracy; (ii) economic performance occurs on or before the earlier of (a) the date that the taxpayer files a return (including extensions) for the taxable year, or (b) the 15th day of the 9th calendar month after the close of the taxable year; (iii) the liability is recurring in nature; and (iv) either the amount of the liability is not material or accrual of the liability in the taxable year results in better matching of the liability against the income to which it relates than would result from accrual of the liability in the taxable year in which economic performance occurs. Section 1.461–5(b)(5)(ii) provides that, in the case of a liability for taxes, the matching requirement of the recurring item exception is deemed satisfied.

.05 Section 3111 imposes a liability on employers for their share of FICA taxes and § 3301 imposes a liability on employers for FUTA taxes. The employer’s portion of FICA taxes consists of a component for old-age, survivors, and disability insurance (social security tax) and a component for hospital insurance tax (Medicare tax). The social security tax applies only to wages paid by an employer to an employee during a calendar year not exceeding the contribution and benefit base (as determined under section 230 of the Social Security Act), which is $102,000 in 2008. Thus, there is a ceiling on the wages subject to social security tax. In contrast, there is no ceiling on wages subject to the Medicare tax. See §§ 3301, 3111, and 3121(a). FUTA taxes are imposed on the first $7,000 of wages paid to a covered employee by an employer during the calendar year. See § 3301(2). Employers are allowed credits against the FUTA tax through participation in state unemployment compensation laws. See § 3301 et seq .

.06 For many years, Service position was that FICA and FUTA taxes for accrual method taxpayers were treated as incurred only in the taxable year the compensation giving rise to the payroll tax liability was paid. For example, Rev. Rul. 69–587,

March 31, 2008 686 2008–13 I.R.B.

.08 Rev. Rul. 2007–12, 2007–11 I.R.B. 685, revoked Rev. Rul. 69–587 and amplified Rev. Rul. 96–51. Rev. Rul. 2007–12 concludes that if the all events test and recurring item exception of § 461 are otherwise met, an accrual method taxpayer may treat its payroll tax liability as incurred in Year 1, regardless of whether the compensation to which the liability relates is deferred compensation that is deductible under § 404 in Year 2.

.09 The Service and the Department of the Treasury recognize that the proper accrual of FICA and FUTA tax liabilities continues to be an area of uncertainty for taxpayers. As noted by the Court of Claims in Eastman Kodak, a taxpayer that has a fixed liability to pay the compensation to which the payroll taxes relate may not know, as of the end of the taxable year, whether a particular employee will have reached any applicable payroll tax ceiling by the time the tax ultimately is paid, raising a question as to when the payroll tax liability is fixed. In addition, the ceiling limitations no longer exist on the Medicare portion of an employer’s payroll tax liability, and the ceiling limitations that still exist on other portions of an employer’s payroll tax liability are significantly higher than those addressed in Eastman Kodak. Therefore, for reasons of administrative convenience and to reduce further controversy, the Service will not challenge a taxpayer’s use of the safe harbor method of accounting described in section 4.01 of this revenue procedure for payroll taxes on compensation.

.10 Under § 446(b), the Commissioner has broad authority to determine whether a method of accounting clearly reflects income. Section 1.446–1(c)(2)(ii) provides that the Commissioner may authorize a taxpayer to adopt or change to a permissible method of accounting although the method is not specifically described in the regulations as permissible if, in the opinion of the Commissioner, that method clearly reflects income.

.11 Section 446(e) and § 1.446– 1(e)(2)(i) state that, except as otherwise provided, a taxpayer must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. Section 1.446–1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations,

terms, and conditions necessary to obtain the Commissioner’s consent to effect the change in method of accounting and to prevent amounts from being duplicated or omitted.

.12 Section 481(a) requires adjustments necessary to prevent amounts from being duplicated or omitted by reason of a change in method of accounting.

.13 Rev. Proc. 2002–9, 2002–1 C.B. 327 (as modified and amplified by Rev. Proc. 2002–19, 2002–1 C.B. 696, modified and clarified by Announcement 2002–17, 2002–1 C.B. 561, and amplified, clarified, and modified by Rev. Proc. 2002–54, 2002–2 C.B. 432), provides procedures by which a taxpayer may obtain automatic consent to change to a method of accounting described in the Appendix of Rev. Proc. 2002–9.